Hussman: Bernanke Creating ‘Bubble’ to Make Americans Feel Better

Economist and fund manager John Hussman says Federal Reserve Chairman Ben Bernanke believes that by creating a bubble in speculative assets, people will "feel" wealthier and keep consuming — regardless of the fact that real incomes are stagnant and debt burdens are already intolerable.

"Undoubtedly, it would be difficult for Bernanke to refrain from (his) reckless policies when everyone is crying 'do something!'" Hussman writes in a note to investors. "But the willingness to tolerate short-term criticism in the interest of long-term benefit is part of what separates leadership from cowardice."

The main effect of the Fed’s quantitative easing has been to provide temporary support for the most speculative corners of the financial market after they have been pummeled, says Hussman, who expects the next round of QE will likely be "sterilized."

“Essentially, the Fed would buy Treasury bonds from banks, and would pay for them with newly created cash, but the Fed would then borrow those funds back from banks, holding them as idle deposits with the Federal Reserve,” Hussman explains.

“By definition, the additional ‘liquidity’ created by a sterilized round of QE would not be available for new lending … the main goal is to increase the outstanding stock of zero- and low-interest assets in the economy, in order to lower the yields and increase the prices of more speculative investments.”

The response of the stock market and other financial assets to quantitative easing is far more based on superstition than on structure, Hussman notes.

"Quantitative easing simply does not relieve any constraint that is binding on the economy," he says. “Rather, QE is a method by which the Fed hoards longer-duration, higher-yielding securities like U.S. Treasury bonds and replaces them with cash that bears zero interest."

The Wall Street Journal reports that improving U.S. economic data this year led investors to reduce expectations for more stimulus from the Fed, but the 120,000 jobs added in March came in below economists' forecasts, has revived speculation that the Fed could implement a new round of quantitative easing, even though another round of outright bond buying by the Fed would tend to weaken the dollar by increasing the supply of money circulating.